Using Rate of Return Analysis, determine the most economical alternative below.
ID: 1090668 • Letter: U
Question
Using Rate of Return Analysis, determine the most economical alternative below. Assume a minimum attractive rate of return of 6%, and a 5-year life with no salvage value for each. The alternatives are mutually exclusive.
Data
Alternatives
A
B
C
D
Initial Cost
$400,000
$100,000
$500,000
$200,000
Annual Costs
$900
$12,000
$23,000
$9,000
Annual Benefits
$101,800
$39,700
$148,200
$55,200
Data
Alternatives
A
B
C
D
Initial Cost
$400,000
$100,000
$500,000
$200,000
Annual Costs
$900
$12,000
$23,000
$9,000
Annual Benefits
$101,800
$39,700
$148,200
$55,200
Explanation / Answer
Annual cash flow of A = 101800-900=100900
NPV of A = -400000 + 100900*(1-1/1.06^5)/6% =25,027.51
Annual cash flow of B = 39700-12000= 27700
NPV of B = -100000 + 27700*(1-1/1.06^5)/6% =$16,682.48
Annual cash flow of C = 148200-23000=125200
NPV of C = -500000 + 125200*(1-1/1.06^5)/6% =27,387.95
Annual cash flow of D = 55200-9000=46200
NPV of A = -200000 + 46200*(1-1/1.06^5)/6% =-5388.79
Alternative C is the best alternative with highest NPV
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